Answer to Question #186016 in Microeconomics for HASAN ALI KHAN

Question

Colgate sells its standard size toothpaste for Rs. 25. Its sales have been on an average 8000 units per month over the last year. Recently, its competitor Sparkle reduced the price of its same standard size toothpaste from Rs. 35 to Rs. 30. As a result Colgate sales declined by 1500 units per month.

i)                   Calculate the cross elasticity between the two products.

ii)                 What does your estimate indicate about the relationship between the two?

Answer 1

a) Cross elasticity (Exy) tells us the relationship between two products. it measures the sensitivity of quantity demand change of product X to a change in the price of product Y.

Cross elasticity formula: Exy = percentage change in Quantity demanded of X / percentage change in Price of Y.

Let colgate be c and sparkle be s

Thus Cross Elasticty Ecs = $[(1500-8000)/8000*100)]/[(30-35)/35*100)]$

$Ecs=-81.25/-14.29$

$Ecs=5.7$

b) Normally, if the Exy > 0, the quantity demanded of X and Price of Y are directly related. X and Y are substitutes.

Thus Colgate and Sparkle are close substitutes.